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July 13, 2011

Ireland Slashed to Junk; EU Considers Greek Default

Moody's warns that Dublin likely to need second bailout

Debt woes continued to plague the euro zone as Moody's on Tuesday downgraded Ireland's governement debt to junk status, while on Wednesday the European Union considered some form of Greek default to avoid spreading the contagion throughout the region.

Moody's also anticipated that Ireland would require a second bailout—something that is still under discussion for Greece, with no decision yet by Eurogroup finance ministers on how it is to be done.

Reuters reported that Moody's issued the warning in anticipation that an additional bailout package would require participation by private investors, whether through haircuts or some other means.

The irony is that, if Greece receives another bailout on those terms—ministers have been considering extensions of bond maturity or an exchange of existing bonds for new, longer-term ones, which ratings agencies have said they would consider forms of default—the likelihood is that Ireland will suffer further cuts to its rating. It has never been rated as junk prior to this.

The Irish government reacted angrily, with its finance ministry issuing a statement that said in part, "This is a disappointing development and it is completely at odds with the recent views of other rating agencies. We are doing all that we can to put our house in order and the progress that we are making is there for all to see." While Ireland's borrowing costs are at a level once thought impossible, thus far it has met all its bailout targets. However, that fact has been overshadowed by events in Greece.

Eurogroup finance ministers said there would be an emergency summit meeting on Friday to further discuss the potential for a Greek default of some kind in order to contain contagion in Italy and Spain. Willem Buiter, chief economist at Citi and a former U.K. central banker, said in the report, "We're talking a game changer here, a systemic crisis. This is existential for the euro area and the EU."

The International Monetary Fund (IMF) also called on Italy to take what it called "decisive" steps to cut its deficit. Concerns that Prime Minister Silvio Berlusconi could be trying to force out Finance Minister Giulio Tremonti, an advocate for fiscal austerity, have caused concerns that Italy will be the next nation to require a bailout, with Spain not far behind.

The Moody's downgrade will likely mean more bad news for Ireland, since investors required to hold only bonds that enjoy investment-grade status from all three major agencies—Moody's, Fitch, and Standard & Poor's—will have to sell them off. That in turn could lead to further downgrades.

Late Monday, Eurogroup ministers had agreed to ease terms for its rescue fund by lowering interest rates, making the fund more flexible and extending loan maturities had been thought by Ireland as the path toward its re-entry to world markets. Its finance ministry said that apparently Moody's had not considered the action in its evaluation.

However, Moody's analyst Dietmar Hornung said in the report that the risk of private investors bearing losses would discourage them from buying Irish bonds. That meant a problem, he said in the report, despite the fact that Moody's was confident the euro zone is "willing to continue to provide liquidity support for peripheral countries and give them time to achieve a sustainable financial position. But at the same time we see a growing possibility that, as a precondition of additional rounds of liquidity support here, private-sector creditors' participation will be required."

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